Despite the market turbulence, RBC Wealth Management outlines a positive outlook for Japanese equities.

Although the Japanese equity market has experienced volatility in recent trading days, RBC Wealth Management believes that short-term volatility and unwinding risks persist, with the unwinding of carry trades is nearing its final stage.

The Japanese equity market dropped dramatically since the start of August after investors took an extreme risk-off stance on the release of weak US economic indicators, suggesting economic slowdown in the US and a sudden appreciation of the Japanese yen. 

The big equity selloff, both domestic retail investors and foreign investors, has brought its positioning in Japanese equities back to neutral. As such, the market has largely priced in the yen’s strength, in RBC WM’s view.

Nevertheless, it thinks that the recent selloff in the Japanese equity market was primarily technical and did not alter the long-term positive outlook for Japanese equities. The firm expects the structural changes in Japan to continue, such as achieving a sustainable inflation target, increased investments from friend-shoring and on-shoring, retail inflows from the revamped Nippon Individual Savings Account scheme, and improved corporate governance. The TOPIX is trading at 13.6x 12-month forward price-to-earnings, below the historical average. It finds Japanese equities attractive at this valuation, the firm said in a statement.

It is also clear that some areas of the US economy are wobbly and others are weak. But it is unclear whether this will end up being a brief hiccup, a GDP growth scare, or a full-blown recession. RBC global asset management chief economist Eric Lascelles pegs the current risk of recession at 40 per cent, up from 35 per cent previously. “But if the data deteriorates further and pushes other leading indicators (out of the seven) to red, the likelihood of a recession could rise,” he added.

There are enough lingering risk factors associated with this selloff to prompt a review of equity portfolio positioning. RBC WM's investment strategist, Jim Allworth, believes that planning for an eventual shift to defensive equity positioning is the best approach.

This means holding no higher than a market weight position in US and global equities in portfolios for the time being, and having a plan to shift the weighting downward if capital preservation becomes a priority. Within equity portfolios, the firm would tilt exposure defensively, with an emphasis on high-quality dividend-paying shares.

This doesn’t rule out holding growth stocks, but it would limit such holdings to quality growth. Core equity holdings should be confined to stocks that can better withstand further economic deterioration or a recession, with valuations supported by prospects for earnings growth.

Other wealth managers are also positive about Japnan’s outlook.“In the short-term, the market may continue to be swayed by foreign exchange rates and the monetary policy of both Japan and the US. However, in the mid to long term the market should calm and return to its former upward trend because Japanese corporate earnings remain robust and Japan’s economy as a whole has been able to escape its deflationary cycle and continues to normalise,” Hiroyuki Ueno, chief strategist at SuMi TRUST said in a note. See more commentary here.